Dr. Doom vs. the soft landing

As long as this blog has been in existence, Morgan Stanley’s Stephen Roach has been pessimistic about the U.S. economy. His latest missive is in today’s Financial Times:

If the world’s dominant deficit economy – the US – goes even deeper into deficit at the same time that the world’s leading surplus economies start to absorb their domestic saving, the noose will tighten on America’s external financing pressures. This raises the distinct possibility that these pressures will have to be vented in world financial markets in the form of a classic current account adjustment – complete with a weaker dollar and higher US interest rates. As long as the rest of the world was in an excess saving position, a big repricing of dollar-denominated assets could be avoided. But now, with surplus economies beginning the long march of absorbing their excess saving, it could well become all the tougher for the US to avoid this treacherous endgame. Sure, this is all theory, leaving unanswered the key question of what it will take to spark the adjustments implied by this theory. There are several possible event risks, or shocks, that I believe would be capable of triggering the rebalancing. They include an energy shock, an outbreak of US protectionism, the bursting of the US housing bubble, a US inflation problem and the uncertainty that always arises during the transition to a new Federal Reserve Board chairman. All of these potential risks have two things in common – they are not a stretch and they could shake the confidence factor that underpins overseas investor appetite for ?dollar-denominated assets. In the end, the history of economic crises is clear on one important thing: the longer any economy holds off in facing its imbalances, the greater the possibility of a hard landing. In my view, an unbalanced world has waited far too long to face up to the heavy lifting of global rebalancing. I would reluctantly conclude that there is now about a 40 per cent probability of a hard landing at some point in the next 12 months.

I’m a bit more sanguine than Roach. The U.S. has already absorbed several energy shocks in the last year, and the reaction by financial markets to Greenspan’s successor has been pretty smooth. I’m just as worried as Roach about US protectionism, but it’s not clear to me that the situation is going to worsen in the next twelve months, and the Doha round is still moving forward — albeit very slowly. [Yeah, but what about the housing market?–ed.] Mary Umberger writes in today’s Chicago Tribune that the National Association of Realtors sees a soft landing rather than a hard one:

America’s historic real estate boom is cresting, and the rate at which home prices appreciate should begin to slow significantly next year, according to the chief economic forecaster for the National Association of Realtors. It was the closest statement yet to an admission by the real estate industry that the bull market for housing may have run its course. “It’s the peak of the boom,” David Lereah said at the Chicago-based trade group’s annual meeting, which ended here Monday. “But we’re looking at a soft landing next year. I can’t guarantee that there won’t be some hard landings in some markets, where prices will actually decline. In fact, there will probably be two or three over the next two years that do pop.” ….In many markets–though not in Chicago–there has been widespread speculation that the boom could turn into an unsustainable bubble that might eventually pop, causing prices to actually fall. Lereah did not see that happening on a national scale, but a real estate market at the peak of its boom doesn’t continue to skyrocket. The NAR’s prediction represents an acknowledgement that this could be the end of a joy ride that has allowed many in the industry to prosper. To make that statement at the real estate industry’s convention–an annual celebration of its role in driving the economy–represented a break from the usual mood. With average 30-year mortgage rates expected to reach 6.7 percent by the end of 2006, Lereah’s forecast on Friday predicted that: – Existing-home sales will decline 3.5 percent next year, to about 6.9 million from this year’s projected 7.1 million; – New-home sales will fall 4.5 percent; – Home price growth should slow significantly–with this year’s median 12.4 percent appreciation slowing to 5.3 percent in 2006…. [chief economist for National City Bank in Cleveland Richard] DeKaser said the NAR prediction of a “modest cooling” is a fair description, though rosier than his own analysis of existing-home sales dropping 7 percent and new-home sales declining by 12 percent. “A downturn the likes of what the NAR is predicting would be almost ideal and welcome,” DeKaser said. “It’s not implausible, just a tad more optimistic than I would be expecting.” Real estate agents at the convention did not focus all their attention on the possible end of the boom. They still found good news to focus on. “Real estate is going to be good forever because of the echo boom generation [born beginning in 1982],” J. Lennox Scott, a leading Seattle-area broker, told a roomful of conventioneers. “They’re going to be streaming into the first-time buyer market: 75 million of them.”

I’m not saying the chances of a hard landing are zero — let’s just say I’m twice as optimistic as Roach. UPDATE: Kash at Angry Bear is more pessimistic — and he has some persuasive reasons. The real question, to me, is not whether the economi